Wednesday, June 8, 2011

Opportunities in Real Estate?

We bought this row house (red, center) at 917 Duke Street in the Historic District of Old Town Alexandria in 1995 for half the asking price - with no money down. Is the current Real Estate Market primed for similar opportunities?

Act Rationally in an Irrational World - I say it over and over again, and yet few people get it. Most folks buy what has already gone up, and then sell when it goes down - buy high, sell low. They jump on the "latest thing!!!" bandwagon every time it comes by - and they are jumping on Gold and Facebook right now as "sure things!" even though gold has probably peaked and Facebook really has no real plan to make any serious money.

And yet people ignore more plebeian opportunities right under their noses. On NPR this morning, a report that home ownership is at all-time lows and that housing prices are at all-time lows and in many markets, the cost of owing is less than renting.

As we discussed previously, your personal residence is not really an "investment" in that it will not return more money than you put into it. It is, however a place to park money and it is a better deal than renting, in normal markets if you plan on staying in one place for at least five years.

Now read that last paragraph again carefully, please. One problem I have with this blog is that people like to read it cafeteria style, and take what they like and turn away the parts that are distasteful or sour. But you get more nutrition from Collard Greens than you do from French Fries, and a balanced diet requires a little of everything.

I did NOT say, "BUY REAL ESTATE!!! It's the next big thing!!!"

I did NOT say, "BUYING IS ALWAYS BETTER THAN RENTING!!!"

I did NOT say, "NOW IS THE TIME TO BUY!!"

I did NOT say, "YOUR HOME IS A GREAT INVESTMENT!!!"

But people want to hear simple answers like that, and those simple answers are what caused the "housing meltdown" of 2009.

There are very relevant parallels between the Real Estate meltdown of 2009 and the meltdown of 1989 - they were exactly 20 years apart. And after each meltdown, people "got scared" of buying Real Estate (Fear - the least useful emotion, remember?) and instead looked to the stock market to salvage their portfolios.

So they all invested in "Dot Com" stocks and we had the bubble of 1995 - about 6 years after the Real Estate Meltdown. And the parallels are relevant, as I think we are right on track for Dot Com Meltdown, Part Deux, in about 2015 or so, when people realize that, no, Groupon is not worth $6 Billion (shoulda taken the Google money, chumps!).

But in the meantime, there may be opportunities for smart investors. First, if you plan on staying in one place for five years or more, look into buying a home - freestanding Real Estate being preferable (far preferable) to Condos or Townhomes. If the cost of owning is less than renting, then it makes sense to own. Interest rates are at an all-time low so it is a good time to lock-in a 30 year fixed rate mortgage.

Lowball the hell out of 'em. Look for distressed sellers or foreclosures. People who HAVE to sell, not dreamers who think they might want to.

The property above was offered at $400,000 and sat on the market for a year with no offers. I offered $200,000. We settled at $210,000. I asked them to take back a second note as a down payment - and they agreed. The overall carrying cost was less than what I was paying in rent for office space. I divided the building into two offices, rented out half, and had the other half rent-free for my office. Eventually, I rented that and moved to a home office. A decade later, I sold the property for $680,000.

Now do the math on that - I put nothing down, and the property paid for itself in terms of cash-flow. What is the profit on that, in terms of percentage? Infinity.

An investment property can be a real cash cow, and with rents climbing (as more people irrationally fear home buying) it could mean good opportunities for landlords. And there are plenty of people out there with good jobs and good incomes - but lousy credit ratings, because they went through foreclosure. They could make good tenants, over time.

But again, you have to "do the math" - whether it is personal home ownership or for a rental property. And if the latter, you need to read my Landlording 101 posting, as maintaining a rental property is not for sissies or people wanting to enact their crazy social justice theories (tenants will walk all over you - welcome to the real world).

Of course, the idea that you might get a "nothing down" deal like I did is a bit far-fetched. Lending practices are much tighter than in years past - most banks want more, in terms of down payment, than before. And it is harder to get loans as well. The fellow with cash right now is king, and since not many of us have cash, prices are plummeting.

And of course, it may be some time before they go up. And that is why having a positive cash flow on Real Estate is important - you need to be making money from the get-go, not hoping for appreciation down the road. And this is true for a personal residence as well as income property. Buying a home and paying MORE than you would to rent it makes no sense, as you likely will be cash-neutral for many years to come.

My projection, based on the 1989 crash is that home prices will stay fairly flat and we will continue to see foreclosures and short sales well into 2013 and 2014. When the dot com and gold markets crash, those foolish investors will, just as they did in 1995, look for the "next big thing!" to invest in.

And they will see on CNN Money how home prices on "on the rise" and then try to cash in on that. And then, well, we will see 2009 all over again, probably in 2029 or thereabouts. People never learn!

Two Important Caveats:

1. Real Estate is very location-driven. The market in Washington DC is far different than the one in Rural South Dakota. If there is no demand, then investing makes no sense, no matter how low prices can go. You have to do the math and add up all the costs and figure out whether you can rent the place at reasonable rents - not some inflated number you make up. Deceiving yourself is really a very foolish game, but many people did just that during the heyday of the 2000's.

2. Condos and Townhouses should be approached with caution - this is not to say they are bad investments, only that you have to "do the math". A recent piece on TeeVee showed how you could buy a "Condo for less than the price of a car!" in Ft. Lauderdale. These were, of course, older garden-style apartments converted to Condos in the 1990's and 2000's and needed extensive renovations (re-bar in the concrete rusts out and it is staggeringly expensive to repair - it is almost easier to tear down and start over!). Also, since many went to foreclosure, no one is paying the condo fees, meaning the remaining owners have to pay double or triple the amounts. $20,000 for a condo is no bargain if there is a $700 a month condo fee and you can rent the same place for $650. Plus, if a certain percentage are in foreclosure or rented, you can't get FHA approved financing, making it basically a cash-only deal.

Yes, you can make money in Real Estate. Yes, there may be opportunities out there right now, for rational people with rational expectations, who know how to use a calculator and don't get caught up in the hoopla or excitement.

It is very sad to me that after an entire meltdown of the economy due to over-exuberance, we see people doing the exact same thing in the stock market with regard to these doit com IPOs. No one wants to make money the old fashioned way it seems, everyone wants to make the "big kill" - and they end up getting killed.